There are so many indicators to take into account when watching the foreign exchange market, but one of the most important is interest rates. They are a strong indicator of the strength or weakness of a country’s currency, and therefore one of the vital considerations when trading Forex.
The basics of interest rates
Interest rates are closely tied to the economic performance of a country, because they are a method of controlling inflation. While steady inflation is considered to be good for economic growth, it’s not ideal if inflation is allowed to run rampant. The central banks within each country therefore monitor and manage interest rates to either slow-down or speed-up economic activity. In Australia, that’s the Reserve Bank; In the US, it’s the Federal Reserve. If the central bank chooses to raise interest rates, then households and businesses tend to lower their spending. If they lower interest rates, then spending tends to increase.
There are few different factors that the reserve banks take into account when deciding whether to raise, lower or leave interest rates. These can include:
• The Consumer Price Index (CPI)
• Current housing markets
• The national employment rate
• Consumer spending.
How can interest rates affect currency values?
Generally speaking, a raise in interest rates will increase the value of that currency when compared to the other side of a currency pair, while a lowered rate will decrease its relative value. However, it’s never quite that simple as there are countless factors that affect a currency value. You will also want to consider the demand for that country’s goods and services as well as the perceived stability of that country’s currency.
How to predict the movements of a country’s interest rates
There are two useful ways to know if interest rates will rise or fall for the currencies you are watching. The first is to listen out for any announcements by the heads of the relevant reserve banks. If they’re discussing how strong the currency is then the interest rate may be about to increase, and vice versa. The second is to read, listen and learn from professional insights and analysis. Often, forecasters will be able to predict how the currency is likely to change based on their assessment of the current CPI, spending, housing market and employment rate combined with other complex factors. If you can move fast and make the right trade based on that information, then that could mean profit for you.